Uncertainty, Task Environment, and Organization Design: An Empirical Investigation

The paper addresses two broad research questions: 1. How do internal uncertainty associated with the task environment and external uncertainty arising from market volatility impact organization design? 2. What are the relationships among various elements of organization design: delegation of decision-making, incentives, monitoring, and internal labor market practices (promotion, training, employment security)? We expand on Prendergast (2002a), who challenged the conventional view of a tradeoff between risk and incentives, and build a single unified framework for answering our two research questions. Using a uniquely rich dataset that contains detailed information about the task environment of core employees and organization design at the individual, group and firms levels in 530 Minnesota firms in the mid 1990s, we first find support for Prendergast's key argument that internal uncertainty (over which employees have control) affects directly the allocation of decision-making and only indirectly incentives (via allocation of decision-making). This confirms similar findings by Foss and Laursen (2005), DeVaro and Kurtulus (2010) and Shi (2011). We also find that internal uncertainty has much impact on organization design through the choice of delegation of decision-making at the employee level, less so at the group level, and very little at the firm level, whereas external (market) uncertainty has little effect on organization design, especially at the individual and group level. Decision-making, monitoring, various internal labor market practices and incentives are strongly related to each other through substitution and complementarity.